The rise of the digital economy has rendered many established ways of collecting sales or income taxes obsolete. But while technology is at the root of this widening tax gap — eroding how governments pay for the provision of high-quality public services — it’s also driving the solutions.
Historically, taxation systems were typically designed to tax sales of goods or services at the point of sale, and corporate and personal income in the location where it is earned. Now, online sales, of retail goods and even services, have blurred borders.
Public-sector groups are also increasingly concerned that some digital companies are exploiting the mobility and intangible nature of digital platforms and goods to sidestep tax, through base erosion and profit shifting (BEPS).
“In many cases, you have a square peg of innovation in a round hole of taxation,” says Jeff Saviano, Americas Tax Innovation Leader. “We are going through a sea change in how national governments are taxing corporations, and the level of transparency that governments — and the citizens they protect — are demanding.”
Here’s one example: A Brazilian consumer can buy low-value goods online to be shipped from elsewhere in the world. Sounds pretty typical these days. But:
- Is the appropriate level of value-added tax (VAT) being charged and collected by the foreign online retailer, or is no VAT being paid?
- How can domestic tax authorities keep track of the VAT that is due?
- Does the foreign online retailer pay income or other taxes in Brazil even though it may not have a physical presence in the country?
Slow-to-change tax policies can often penalize traditional companies and reward the upstarts without necessarily meaning to. Brick-and-mortar retailers, for example, complain that online rivals have an unfair advantage as they can “jurisdiction shop” for the lowest tax rates and sidestep in-country property and other taxes.
The sharing economy is also adding vast numbers of new transactions without a clear taxation model. Consider the hospitality industry: Historically, many city authorities have taxed hotel users. Now some cities, such as Paris, are trying to tax those who rent their spare rooms to short-stay visitors.
Also, traditional definitions of employee status — which shape liabilities for income tax and social contributions — are being challenged by the “gig” economy, in which internet platforms are used to connect freelance workers with providers of services.
BEPS and the future of tax
The G-20 called upon the Paris-based Organisation for Economic Co-operation and Development (OECD) in 2012 to study reforms to the global taxation system to address BEPS. Its BEPS report in October 2015 formally suggested governments take critical actions with regard to taxation and the digital economy. Recommended overall options include:
- Changing the controlled foreign company (CFC) rules
- Updating transfer pricing guidelines
- Adopting a stricter definition of what constitutes a permanent establishment (a taxable presence)
- Addressing indirect taxes for certain digital transactions